Something I have learned over the past decade is that value investing is not for everyone -- a lesson I wish I had learned sooner.
It is straightforward to read through the initial partnership letters of Warren Buffett (Trades, Portfolio), a renowned value investor, and think that it is easy to follow the strategy of buying cheap stocks and beat the market in the process.
In reality, being a value investor requires much more than just buying and selling stocks. It requires discipline, patience, knowledge of accounting practices and, above all, experience.
Discipline, patience and experience
To be a successful value investor, you have to have every single one of the qualities above.
Unfortunately, it is impossible to learn these qualities overnight.
It takes years of practice, research and multidisciplinary learning to really understand how value investing works and make the most of the strategy.
I think the most important lesson I have learned concerning value investing over the past 10 years is the fact there is much more to this style than just reviewing the numbers.
Anyone can pick cheap stocks; all you need to do is go out and screen the market for any equities trading at a price-book value of less than one. But distilling this basket of equities down into a useful investment portfolio is another thing altogether.
Buffett has said he used to use the Moody's manual to find cheap stocks, but when he discovered these inexpensive businesses, he didn't just buy them without any further research.
The guru's portfolio, when he was managing his investment partnerships, tended to be quite small. He only added the companies he was 100% sure were undervalued with hidden assets. (Walter Schloss, on the other hand, did buy lots of cheap stocks, although his returns were nowhere near as impressive as those of Buffett.)
This is where it is vital to understand not just a company's valuation, but it's balance sheet as well. Investors need to know where the value has come from, what assets make up the balance sheet and how successful management has been at growing shareholder equity in the past.
For example, there is no sense buying a stock trading at 0.3 of book if its book value has shrunk 10% per annum over the past decade. Investors need to understand accounting to know comprehend how the company is making money and where it is going.
The presence of value also varies from sector to sector. When Buffett and the rest of the "Super Investors" of Graham and Doddsville were practicing their value trade in the 1960s, '70s and '80s, companies relied on investments in tangible assets to produce returns.
Today, intangible assets are much more important. How do you place a value on a brand, for example? You can only do this if you have experience in the sector, and experience valuing companies in general.
Then there is the psychological side of investing to understand. I would argue that understanding market psychology and the makeup of the markets is more important today than it has ever been before. It is easy to buy a cheap stock, but one question we should always ask before entering a position is: What does the rest of the market know that I don't?
Understanding market psychology and investment trends will help you answer this question.
Once again, you will only be able to answer this question if you have experience as an investor.
In conclusion, over the past 10 years, I have learned that investing is nowhere near as simple as it first appeared. In particular, there's much more to value investing than just buying cheap stocks.
Read more here:
- What Type of Investor Are You?
- What We Can Learn From Buffett's See's Candies Deal
- A Look at Berkshire Hathaway's Insurance Business
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